Hostname: page-component-848d4c4894-hfldf Total loading time: 0 Render date: 2024-05-22T07:02:04.964Z Has data issue: false hasContentIssue false

Dynamic Capital Structure Adjustment and the Impact of Fractional Dependent Variables

Published online by Cambridge University Press:  23 December 2015

Ralf Elsas
Affiliation:
elsas@bwl.lmu.de, Ludwig Maximilian University of Munich, Faculty of Business Administration (Munich School of Management), Munich 80539, Germany.
David Florysiak*
Affiliation:
florysiak@bwl.lmu.de, Ludwig Maximilian University of Munich, Faculty of Business Administration (Munich School of Management), Munich 80539, Germany.
*
*Corresponding author: florysiak@bwl.lmu.de

Abstract

Researchers in empirical corporate finance often use bounded ratios (e.g., debt ratios) as dependent variables in their regressions. Using the example of estimating the speed of adjustment toward target leverage, we show by Monte Carlo and resampling experiments that commonly applied estimators yield severely biased estimates, as they ignore that debt ratios are fractional (i.e., bounded between 0 and 1). We propose a new unbiased estimator for adjustment speed in the presence of fractional dependent variables that also controls for unobserved heterogeneity and unbalanced panel data. This new estimator is suitable for corporate finance applications beyond capital structure research.

Type
Research Articles
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2015 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Alti, A. “How Persistent Is the Impact of Market Timing on Capital Structure?” Journal of Finance, 61 (2006), 16811710.Google Scholar
Arellano, M., and Bond, S.. “Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations.” Review of Economic Studies, 58 (1991), 277297.CrossRefGoogle Scholar
Baker, M., and Wurgler, J.. “Market Timing and Capital Structure.” Journal of Finance, 57 (2002), 132.Google Scholar
Baltagi, B. H. Econometric Analysis of Panel Data. West Sussex, England: John Wiley & Sons (2005).Google Scholar
Blundell, R., and Bond, S.. “Initial Conditions and Moment Restrictions in Dynamic Panel Data Models.” Journal of Econometrics, 87 (1998), 115143.Google Scholar
Bollerslev, T., and Wooldridge, J. M.. “Quasi-Maximum Likelihood Estimation and Inference in Dynamic Models with Time-Varying Covariances.” Econometric Reviews, 11 (1992), 143172.Google Scholar
Bruno, G. S. F. “Approximating the Bias of the LSDVC Estimator for Dynamic Unbalanced Panel Data Models.” Economics Letters, 87 (2005a), 361366.Google Scholar
Bruno, G. S. F. “Estimation and Inference in Dynamic Unbalanced Panel-Data Models with a Small Number of Individuals.” Stata Journal, 5 (2005b), 473500.CrossRefGoogle Scholar
Chamberlain, G. “Analysis of Covariance with Qualitative Data.” Review of Economic Studies, 47 (1980), 225238.CrossRefGoogle Scholar
Chang, X., and Dasgupta, S.. “Target Behavior and Financing: How Conclusive Is the Evidence?” Journal of Finance, 64 (2009), 17671796.CrossRefGoogle Scholar
Dittmar, A., and Thakor, A.. “Why Do Firms Issue Equity?” Journal of Finance, 62 (2007), 154.Google Scholar
Elsas, R., and Florysiak, D.. “Heterogeneity in the Speed of Adjustment toward Target Leverage.” International Review of Finance, 11 (2011), 181211.Google Scholar
Fama, E. F., and French, K. R.. “Industry Costs of Equity.” Journal of Financial Economics, 43 (1997), 153193.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Testing Trade-Off and Pecking Order Predictions about Dividends and Debt.” Review of Financial Studies, 15 (2002), 133.CrossRefGoogle Scholar
Fama, E. F., and MacBeth, J. D.. “Risk, Return, and Equilibrium: Empirical Tests.” Journal of Political Economy, 81 (1973), 607636.Google Scholar
Faulkender, M.; Flannery, M. J.; Hankins, K. W.; and Smith, J. M.. “Cash Flows and Leverage Adjustments.” Journal of Financial Economics, 103 (2012), 632646.Google Scholar
Fischer, E. O.; Heinkel, R.; and Zechner, J.. “Dynamic Capital Structure Choice: Theory and Tests.” Journal of Finance, 44 (1989), 1940.CrossRefGoogle Scholar
Flannery, M. J., and Hankins, K. W.. “Estimating Dynamic Panel Models in Corporate Finance.” Journal of Corporate Finance, 19 (2013), 119.CrossRefGoogle Scholar
Flannery, M. J., and Rangan, K. P.. “Partial Adjustment toward Target Capital Structures.” Journal of Financial Economics, 79 (2006), 469506.Google Scholar
Frank, M. Z., and Goyal, V. K.. “Tradeoff and Pecking Order Theories of Debt.” In Handbook of Empirical Corporate Finance, Vol. 2, Eckbo, B. E., ed. Amsterdam: Elsevier Science (2008), 135202.CrossRefGoogle Scholar
Graham, J. R., and Harvey, R. C.. “The Theory and Practice of Corporate Finance: Evidence from the Field.” Journal of Financial Economics, 60 (2001), 187243.Google Scholar
Graham, J. R., and Leary, M. T.. “A Review of Empirical Capital Structure Research and Directions for the Future.” Annual Review of Financial Economics, 3 (2011), 309345.CrossRefGoogle Scholar
Greene, W. H. Econometric Analysis, 7th ed.Upper Saddle River, NJ: Prentice-Hall (2011).Google Scholar
Hahn, J.; Hausman, J.; and Kuersteiner, G.. “Long Difference Instrumental Variables Estimation for Dynamic Panel Models with Fixed Effects.” Journal of Econometrics, 140 (2007), 574617.CrossRefGoogle Scholar
Hovakimian, A., and Li, G.. “Is the Partial Adjustment Model a Useful Tool for Capital Structure Research?” Review of Finance, 16 (2012), 733754.CrossRefGoogle Scholar
Huang, R., and Ritter, J. R.. “Testing Theories of Capital Structure and Estimating the Speed of Adjustment.” Journal of Financial and Quantitative Analysis, 44 (2009), 237271.Google Scholar
Iliev, P., and Welch, I.. “Reconciling Estimates of the Speed of Adjustment of Leverage Ratios.” Working Paper, Pennsylvania State University (2010).Google Scholar
Kayhan, A., and Titman, S.. “Firms’ Histories and Their Capital Structures.” Journal of Financial Economics, 83 (2007), 132.Google Scholar
Kisgen, D. J.“Credit Ratings and Capital Structure.” Journal of Finance, 61 (2006), 10351073.Google Scholar
Kisgen, D. J. “Do Firms Target Credit Ratings or Leverage Levels?” Journal of Financial and Quantitative Analysis, 44 (2009), 13231344.Google Scholar
Kiviet, J. F. “On Bias, Inconsistency, and Efficiency of Various Estimators in Dynamic Panel Data Models.” Journal of Econometrics, 68 (1995), 5378.Google Scholar
Leary, M. T., and Roberts, M. R.. “Do Firms Rebalance Their Capital Structures?” Journal of Finance, 60 (2005), 25752619.Google Scholar
Lemmon, M. L.; Roberts, M. R.; and Zender, J. F.. “Back to the Beginning: Persistence and the Cross-Section of Corporate Capital Structure.” Journal of Finance, 63 (2008), 15751608.Google Scholar
Lockhart, G. B. “Adjusting to Target Capital Structure: The Effect of Credit Lines.” Working Paper, University of Nebraska–Lincoln (2010).Google Scholar
Loudermilk, M. S. “Estimation of Fractional Dependent Variables in Dynamic Panel Data Models with an Application to Firm Dividend Policy.” Journal of Business and Economic Statistics, 25 (2007), 462472.CrossRefGoogle Scholar
Mundlak, Y. “On the Pooling of Time Series and Cross Section Data.” Econometrica, 46 (1978), 6985.Google Scholar
Nickell, S. “Biases in Dynamic Models with Fixed Effects.” Econometrica, 49 (1981), 14171426.CrossRefGoogle Scholar
Oztekin, O., and Flannery, M. J.. “Institutional Determinants of Capital Structure Adjustment Speeds.” Journal of Financial Economics, 103 (2012), 88112.Google Scholar
Papke, L. E., and Wooldridge, J. M.. “Panel Data Methods for Fractional Response Variables with an Application to Test Pass Rates.” Journal of Econometrics, 145 (2008), 121133.Google Scholar
Strebulaev, I. A. “Do Tests of Capital Structure Theory Mean What They Say?” Journal of Finance, 62 (2007), 17471787.CrossRefGoogle Scholar
Titman, S., and Tsyplakov, S.. “A Dynamic Model of Optimal Capital Structure.” Review of Finance, 11 (2007), 401451.CrossRefGoogle Scholar
Welch, I.“Capital Structure and Stock Returns.” Journal of Political Economy, 112 (2004), 106131.Google Scholar
Welch, I. “Two Common Problems in Capital Structure Research: The Financial-Debt-to-Asset Ratio and Issuing Activity versus Leverage Changes.” International Review of Finance, 11 (2011), 117.Google Scholar
Wooldridge, J. M.“Fixed-Effects and Related Estimators for Correlated Random-Coefficient and Treatment-Effect Panel Data Models.” Review of Economics and Statistics, 87 (2005), 385390.Google Scholar
Supplementary material: Link

Elsas and Florysiak supplementary material

Link
Supplementary material: PDF

Elsas and Florysiak supplementary material

Internet Appendix

Download Elsas and Florysiak supplementary material(PDF)
PDF 251.6 KB